Conservative Investors
Line Up for Junk Bonds

When
Christopher Towle,
a portfolio manager at Lord Abbett, checked the list of attendees at a high-yield, or junk, bond conference in October, he saw a lot of unfamiliar names.

That's because investors who typically channel their money into more conservative investment-grade corporate debt had signed up to learn more about higher-yielding, riskier junk bonds.

In some cases, institutional bond investors like insurance companies sent 20 people "because the whole high-grade staff would come to get up to speed," Mr. Towle said.

The junk-bond market is undergoing a sort of gentrification, appealing to more conservative investors, who, like many in the current low-yield environment, are starved for higher returns.

Pension funds, for one, have been squeezed by low yields since they make it harder to cover longer-term liabilities. Many of these funds need to hit targets on the order of 8% to 8.5%, noted
Nasri Toutoungi,
portfolio manager of the Hartford Total Return Bond Fund. "I think there's a real scramble to try to get there."

Total return funds, like Mr. Toutoungi's, are comprised predominantly of investment-grade holdings but allow portfolio managers to, in most cases, hold a 20% basket of high-yield bonds.

Mr. Toutoungi increased his junk-bond holdings from a low of 6% or 7% to 15% of his fund last summer, where it remains. It was a smart move considering returns in the high-yield market were 11.74% last year, according to Merrill Lynch High-Yield Master Index. The investment-grade corporate-bond market turned out only 4.33%, according to the Lehman Aggregate Index.

Mr. Towle said buying has turned into clamoring for new issues in the high-yield market.

"On some of these larger deals, you're frequently hearing the underwriter saying there are 500 accounts circling in on these deals and you're saying 'What? How did this happen?'" he said. He said a growing number of accounts are crossover investors in need of extra yield.

Some investors remain cautious.

Steven Lear,
head of fixed-income at Schroder Investment Management, says his fund has remained in the mid range in terms of the allowance for junk bonds in its crossover fund. "We see great demand in the marketplace but we're very selective in what we buy. It feels like there are a lot of people throwing money at the sector."

Junk debt is inherently riskier than investment-grade debt because the issuing companies have weaker credit profiles with, in most cases, already high debt levels. Yet the high-yield market has been perceived as less risky lately because the default rate has remained well below historic averages. Fitch Ratings measured the U.S. high-yield default rate at a record low of 0.8% last year, down from 3.1% in 2005 and well below the long-term average of 5%.

A spike in the default rate, expected as economic growth slows, could spell losses for investment-grade players who don't time their exit right. "Typically investors change their willingness to take on risk too late in the cycle," said
Mark Kiesel,
executive vice president at PIMCO.

Treasurys Retreat in Reaction to Consumer-Sentiment Survey

The benchmark 10-year Treasury exited active trade Friday down 6/32 point, or $1.875 per $1,000 face value, at 98 27/32. Its yield, which moves inversely to price, rose to 4.773%. The two-year note, the most sensitive to monetary-policy changes, was down 2/32 point at 99 22/32 to yield 4.919%.

Michael Cloherty,
chief Treasurys trading strategist at Bank of America Securities in New York, said "the last leg" of the morning selling was inspired by a stronger-than-expected University of Michigan consumer-sentiment survey. However, in the absence of any "dominant theme" in the market, the selling was contained, Mr. Cloherty said.